Emerging business owners who have qualified research expenses (QREs) and no taxable income may still be able to offset their investments in research and development (R&D) innovation via tax credits. This is possible because of a provision known as the federal R&D tax credit carryforward.
What is the R&D tax credit carryforward?
As the name implies, the R&D tax credit carryforward allows businesses to take unused R&D tax credits generated from a given year's QREs and apply them to future tax liabilities. This circumstance typically applies to businesses that either invested in R&D and did not turn a profit, or were eligible for a larger tax credit than what they currently owed or paid in income taxes.
What happens to unused R&D credits?
Unused R&D tax credits may still be available to eligible businesses if they file amended tax returns for the years in which they failed to claim the credit. Businesses can then carry forward the unused credits for up to 20 years after first carrying them back for one year.
What is a carryforward credit?
A carryforward credit is the application of a tax credit to a future tax year. This provision exists so that businesses can take advantage of tax credits that were unused because of operating losses or IRS imposed limits on how much can be claimed in a single year. The R&D tax credit is an example of a carryforward credit.
How far back can you claim R&D tax credits?
Generally, businesses can claim R&D tax credits for tax returns with an open statute of limitations, which typically includes the prior three years. If the taxpayer had non-taxable or loss years in tax years where the statute of limitations is closed, they may be able to go back several additional years to calculate credits and carry them forward to taxable years on a carryforward schedule for up to 20 years until utilized.
In order to claim a refund, carryforward credits have to be carried forward to an open, amendable tax return. The carryforward credits must also be reduced by any amounts that could have been utilized in closed taxable years during the carryforward period.
How does the R&D tax credit carryforward work?
Businesses that carry forward R&D tax credits may be able to offset tax liability in future years. To do so, they must first perform an R&D tax credit study and claim the R&D tax credit by filing IRS Form 6765, Credit for Increasing Research Activities.
Was the R&D tax credit carryforward affected by the Tax Cuts and Jobs Act?
Yes, the Tax Cuts and Jobs Act (TCJA) eliminated the alternative minimum tax (AMT) for C-corporations and provided businesses with the opportunity to further reduce their tax bills using past, present and future R&D tax credits. It also amended Internal Revenue Code (IRC) Sec. 172(a) for tax years beginning after December 31, 2017, restricting the application of net operating losses (NOLs) to 80% of taxable income.
This amendment may motivate some taxpayers to look to the R&D tax credit as another potential tax offset based on their QREs. However, the TJCA's 80% limitation was temporarily suspended by the 2020 CARES Act and will be reinstated for tax years beginning after 2020.
Are there additional limitations?
Yes, under the TCJA, the "25/25 limitation" restricts C-corporations with over $25,000 in regular tax liability from offsetting more than 75% of their tax liability using the R&D tax credit. Also, the IRC Sec. 38 (c) limitation restricts the amount of tax liability that can be offset to the greater of either the tentative minimum tax or 25% of any tax liability greater than $25,000.
How can ADP help my business take advantage of eligible tax credits?
ADP has the expertise, experience, technology and resources to help make claiming tax credits as easy and predictable as possible. We collaborate with clients on the best ways to utilize credits, including carryforward credits, and can assist with financial inquiries. ADP also maintains relationships with federal, state and local government agencies, which allows us to proactively notify clients of any changes in legislation or compliance requirements that could affect our tax credit services.
Learn more about ADP's tax credit services
Frequently asked questions about the R&D tax credit carryforward
Do carryforward R&D tax credits expire?
Yes, R&D tax credits that are carried forward and remain unused after a period of 20 years expire. When this happens, businesses may no longer use the credits to offset tax liability.
What if I missed claiming the R&D tax credit in previous years?
Business owners who were eligible for the R&D tax credit, but did not claim it, can file amended tax returns for up to three years. If they suffered losses, they may be able to make retroactive claims even further back.
What are the R&D credit carryforward rules for California?
While the federal government places a 20-year expiration date on unused R&D tax credits, the state of California allows employers to carry forward R&D tax credits until they are exhausted.1
